Debt Resolution

A Guide to Bad Debt Recovery Process

What is Bad Debt Recovery?

When the payment received for a loan cannot be collected, it can be called a bad debt. Every organization or business goes through unpaid customer accounts, where they cannot collect the money. Bad debt recovery can also happen if legal action is taken to collect the debt. Though the lender gets the money back, going through the process can be challenging and time-consuming.

A lender can get his money back by selling the borrower’s collateral; if a car loan is taken and the borrower cannot pay the loan on time, the lender can take back the car, sell it, and get his loan money back. If the debts help you enhance your life’s quality, they can be called good debts, for example, student loans, mortgages, business investments, etc.

Unhappy customers also play a part in bad debts. If your customers are unhappy with what they have received, they might either delay the payment or hold the charge. The lender can get tired of pursuing the pending payment, which is when it is written off as bad debt.

Different Types of Bad Debts

The Internal Revenue Service (IRS) classifies bad debts into two; business and nonbusiness. Once you know the differences between the two, you will have a clear idea of how to report bad debt recovery to the IRS. Businesses can report they’re bad debt losses to the IRS, and in case they recover the funds, the businesses or traders are expected to reverse the loss.

Credit cards can be classified as bad debts because you use them to buy superficial things. Remember the rewards programs of the banks while using the credit card. If you are lending money to a friend or a relative who may not repay it, you can look at it as a gift and should not include it under bad debt.

Business Bad Debt

A loss incurred that is created, related to business, or acquired in a business is a bad business debt. Business owners will have to deduct these bad debts from their gross income while trying to figure out the taxable income of their businesses. 

Some examples of a bad business debt are:

  • A loan guarantee is given to a business
  • A credit sale is given to a customer
  • A loan that is given to a client, distributor, employee, or supplier

Nonbusiness Bad Debt

All other bad debts except the ones mentioned above are nonbusiness bad debts. The business owner or trader must show that they have tried to collect the payment before they can write it off as a non-business bad debt.

If the court judgment shows it as uncollectible, then it is unnecessary to go to court. A nonbusiness debt can also be reported as a short-term capital loss on Form 8949, Sales and Other Dispositions of Capital Assets, Part 1, line 1. A separate detailed statement should be attached to the return for deduction for a nonbusiness debt. The statement should include the debt’s description, the due date of the amount and date, the debtor’s name, the relationship between the debtor and the business, if it is formal or personal, the efforts made for debt collection, and why the organization thinks it is uncollectible. 

A Guide to Bad Debt Recovery Process

Business owners always face bad debts, and there is nothing new about it. The borrower’s financial records might be excellent, but they still might not be able to pay the lender’s money in the stipulated time. The business owner or lender might want to get the money back quickly and with little effort. 

Some of the steps that can be taken for bad debt recovery are:

1. Locate the Debtors 

The first step will be to locate these debtors who are hard to find and track them down. Lenders must ensure the customer database is ready through a contact management tool. Try to contact them and collect the unpaid money. Keep monitoring their account so that you will know when their ability to pay has improved, and then request them to pay the outstanding balance.

2. Send an Official Letter

This is the easiest way to contact the borrower and remind them about their pending payment. The lender must notify the borrower before he can write it off as an uncollectable amount. A hard copy letter implies the graveness of the situation, though the collections CRM (Customer Relationship Management) automatically sends a mail based on the Days Past Due (DPD). Let the tone in the letter be firm, making the intention to collect the payment very clear.

3. Take the Services of a Collection Agency

It is best to go through a debt collection agency. They will contact the debtors through phone calls, emails, and litigation if the need arises. They can also assist them with a payment plan. Contact a professional collection agency; they will know how to tackle the problem amicably without spoiling the lender’s relationship with the borrower. The debt collection agency will also help the business owners to file a lawsuit if required. The agency keeps some of the amounts they have collected for the lenders.

4. Issue a Court Case

Contemplating a court case to resolve the issue is advisable if the amount is very high. There is no guarantee the case might go in favor of the lender, and the lender will also have to incur court fees.

It is better to note that before any of the above actions are taken for bad debt recovery, the businesses can check if an invoice has been issued and sent to the borrower. The customer can also be contacted via email or an automated phone call and reminded the payment is overdue. The business owner can request them to pay and remind them about the penalties or the interest rate. A staff member can follow up by email and phone call, and if all of this is done and the payment is still pending, then the above strategies can be applied.

Putting problematic accounts on hold will also help resolve the issues to a large extent. Once the customers delay the payments, it is best to put their accounts on hold to avoid problems in the future. It will also help to decide if the credit account needs to be revised or eliminated.

Guide to bad debt recovery process


Improving the debt recovery process to cut costs and maximize resources is essential. The above bad debt recovery process is an excellent way to take care of your debt management and recovery process and strengthen the bad debt recovery process. Nowadays, there is also debt collection software that will make the bad debt recovery process easy to handle with more accuracy and efficiency.

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by Mamta

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